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The Evolution of Life Insurance

Jun 19, 2012

There is a misconception that is prevalent in our society and this misconception is that every individual needs life insurance. This is not true. Neither is it true that every earning individual, a sub set of the former category, needs life insurance.

You need life insurance if you have financial dependents, and you need to plan and provide for their life goals, or if you have liabilities such as a car loan or any other loan, and you do not want this loan to devolve onto your financial dependents in case of your untimely demise. In these circumstances, you do need adequate life insurance. In fact, because life insurance is so important for these individuals, it is one of the first aspects addressed in your financial plan.

While your life is definitely priceless to your loved ones, it is however important to put an actual number on the value of the breadwinner in the family, so that you know how much life insurance you actually require. This way, in case of any unfortunate circumstance, your loved ones have some income that they will receive that can help them meet their financial needs.

The Evolution of Life Insurance

Do all life insurance policies pay out only on death of the policy holder? Are there other types? Life insurance comes in a few different forms; let's see what these are and what purposes each one serves:

The Term Plan

The first form is one of pure protection - the Term Plan. This pays only on the death of the policy holder. It is pure insurance and has the lowest premium for the highest payout. If you survive the term of the policy, you do not receive any payment. Your premiums paid go fully toward insuring your life. There is no investment made out of your premiums in a Term Plan, hence it is called a pure insurance policy. The term plan is available in two forms, the online and the offline term plan - each has its own pros and cons.

The Endowment Policy

Because to some people the term plan seemed like a waste of premiums paid over the years in case of surviving the policy period, life insurance companies modified their product to come up with the Endowment Policy.

Here, the premium is significantly higher than a Term Plan. Part of the premium goes towards insuring your life, and the rest is invested in fixed income products that yield a very low rate of return (approximately 5% per annum). From the future corpus of the invested amount of your premiums, the Endowment Policy pays out the Sum Assured to the nominated beneficiary on the death of the policy holder and even if the policy holder survives the policy term, he or she receives a defined payout on maturity of the policy. So this type of product addressed the concern of premiums not yielding any profits, even though that is not what life insurance premiums are supposed to do.

The Money Back Policy

While the term plan addressed the needs of those who wanted pure life insurance, and the endowment policy addressed the needs of those who wanted a payout even on survival of the policy period, there remained a gap - the people who wanted interim payouts on surviving part of the term, and didn't want to wait until the end of the policy period to receive their Sum Assured.

So the money back policy was born - giving interim payouts (or money back) depending on survival of a certain defined period. For example, on survival of 5 years, 10 years and 15 years of the term, the policy holder receives a certain sum of money back from the insurance company. These policies pay out the same rate of return as endowment policies i.e. roughly 5% per annum.

This again is a savings plus investment product, like the endowment policy. You should also know the difference between your term, money back and endowment policies - i.e. know which policy is better for you.

ULIPs and ULPPS

While endowments and money back plans invest in safe fixed income instruments yielding very low rates of return, diversification prompted the creation of a life insurance product that invested into equity and so the ULIP and ULPP were born. Unit Linked Insurance Plans and Unit Linked Pension Plans invest a chunk of the very high annual premium into equity, and a very small component goes towards paying for actual life insurance. Thus these products are savings based and market linked investment plans.

What's the common factor here?

Regardless of what policy type you go for (and remember - at PersonalFN we recommend only pure term plans), you do need to read your policy document very, very carefully to ensure that the policy is the right one for you. Don't depend on your insurance agent to tell you everything you need to know, for two reasons.

Firstly, they work on a commission basis. If you buy a policy, they get a 25% (at least) commission on the sale. So it's good for them to make you buy. They won't be pointing out flaws in policies any time soon.

Secondly, based on extensive discussion with a number of insurance agents, it is seen that often the intricate details of the policy are not known by the agents. This is not as much a result of the agent's lack of time to study the policy as it is of the insurance company's training and development teams' lethargy.

So, we're in a situation of 'caveat emptor'. The onus of understanding the product lies on you - the buyer. In today's world which is full of uncertainties, buying life insurance has become inevitable for almost every individual; but while buying it you should also always make sure that you understand each and every term contained in the policy document. Some of these terms might seem simple and you would want to ignore them, but it is extremely important that you understand all of these terms.

Here is a list of some of the terms contained in life insurance policies which can help you to better understand your life insurance policy. Some of the simplified life insurance terms are as follows:

Life Assured: Life assured is the person who will be covered under the life insurance policy. It might be the same person who is paying the premium but not compulsory as in case an individual paying premium for his spouse, in such a scenario life assured is spouse and not the person paying the premium.

Proposer: Proposer is the person who is paying the premium under the life insurance policy and is not necessarily life assured under the policy.

Nominee: Nominee is the person who will receive the death benefits under the life insurance policy in case of the death of the life assured.

Date of Commencement: Date of Commencement is the start date of the policy from which insurance cover will be effective.

Sum Assured:Sum Assured is the amount of insurance cover you will get under the policy. This amount is payable to the nominee in case of deathof the life assured.

Premium: Premium is the amount you will pay under the insurance policy for getting the insurance cover.

Term: Term is the duration of the policy for which the insurance policy will be valid.

Premium Paying Term: Premium Paying Term is the duration under the policy for which the Premium amount has to be paid. It can differ from the Term of the policy as in some insurance policies Premium Paying Term is less than the Term of the policy.

Mode: Mode is the frequency of premium payment; it can be Monthly, Quarterly, Half-Yearly, Yearly or it might be Single Premium in case you have to pay only 1 premium for the whole Term of the policy.

Maturity Date: Maturity Date is the date when all your benefits under life insurance policy will cease and you will no longer be covered under the policy. Any maturity benefit will be paid out and the policy will be closed.

Survival Benefit: Survival benefit is the amount payable in case of money back policy. This amount is paid as a benefit after every few years during the term of the policy. It usually ranges between 15-25% of sum assured.

Surrender Value:Surrender value is the amount you will receive in case you do not wish to continue with the policy. It is the certain percentage of the premiums paid (after deduction of surrender charges) which you will receive in case you surrender the policy.

Fund Value: Fund value is applicable in case of Unit Linked Insurance Plans (ULIP). It is the current value of your investment made towards ULIP. This investment is market linked and will fluctuate depending upon the performance of the fund manager managing the portfolio.

Maturity Value: Maturity Value is the amount which you will receive at the time of maturity of the policy.

Even though the above mentioned terms might look very simple to you but it is very important that you understand them while taking the policy. This will ensure that you know what you are buying. Also check out our Human Life Value calculator so you know how much life insurance you really need, to protect your loved ones in case of any unfortunate circumstances.

If you find upon review that you have taken a policy that is not suitable for you, you can also take certain steps if you are dis-satisfied with your policy.And remember, insurance is a part of holistic financial planning and should be taken in line with your life goals and needs.

PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.

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